The speed and efficiency through which investments can be executed through electronic trading systems provide many benefits. In many markets, Electronic Exchanges facilitate a greater number of market participants than do other Trading Exchanges. The greater the number of market participants, the greater the market's liquidity. In liquid markets, prices are driven down by competition; prices reflect a consensus of what an investment is worth; and the trading systems provide a free and open dissemination of information.
While speed and efficiency of many electronic markets can enhance market participant's wealth, these same qualities can increase the adverse affect of a trade that is executed in error. Specifically, orders executed at prices substantially away from a market price can cause other market participants both in their markets and in related markets to make unsound decisions. In a futures market, for example, a buyer's large order executed at a price much higher than a prevailing market price can cause other sellers to substantially raise their prices, ultimately, pricing some buyers out of that market and leading to executed transactions that result in substantial losses for other buyers. In futures markets these errors can induce buyers and sellers in that market, in a related derivative market, and/or in an underlying cash market to make unsound decisions. The harmful effect of an erroneous trade can extend well beyond the market participants of that trade by affecting the integrity of the entire market and other markets. Furthermore, undetected erroneous trades may have a lasting impact on historical price information and various technical charting strategies used by market participants.
To mitigate these harmful effects, some Exchanges have adopted policies and procedures that, in appropriate cases, permit the cancellation of a clearly erroneous trade. Some of these Exchanges attempt a prompt resolution of a trade error by establishing a narrow timeframe within which a party may request that a trade be cancelled. To assure that only erroneous trades that may significantly affect other market participants are the only trades subject to cancellation, some Exchanges adopted a “no-bust range.” In a “no-bust range,” erroneous trades executed within a price range may not be subject to cancellation, even if executed in error to avoid penalizing the innocent traders that lack notice. Unfortunately, the “no-bust range” can be susceptible to subjectivity as Exchanges are not always able to define an “erroneous price.”
Although many policies and procedures are intended to enhance the integrity of markets, some are not agile enough to respond to the many errors that an Electronic Exchange encounters. The increasing use of automated arbitrage systems, for example, allow some market participants to benefit from erroneous prices. Such failures penalize counterparties to those trades, and create risk and uncertainty by artificially influencing the value of those trades. Some approaches do not scale well to large networks, new products, or the large volatility that occurs in those markets that trade popular contracts. These approaches can require repeated modifications that increase price instability and distort price discovery.